The Big Guns of August

US Treasury holders have nothing to fear today. Just look how low yields
are!

"BOY, the bond vigilantes are really on the warpath," jokes Paul Krugman,
noting in his blog at the NY
Times that 10-year Treasury yields ended Tuesday below 3.0%.

Never mind that the S&P slumped to 1040 meantime, dropping to a level
first crossed (on the way up) in spring 1998 and leaving institutional funds
with few places to hide. Never mind that 10-year Treasury yields only fell
through 3.0% once before...amid the cataclysm that followed Lehman Bros.' collapse
and thus hardly cause for good cheer. And never mind either that gold
prices reversed a 0.9% drop on Tuesday, extending their run of higher highs
and higher lows to seven consecutive quarters, also starting with the collapse
of Lehmans.

"Clearly, we must slash spending immediately to satisfy the market's demands," mocks
the Princeton professor. Which looks a fair satire at first. Because yields
only fall when bond buyers bid up prices. And US debt has rarely been more
highly priced than today.

But to think that means the market is crying out for more debt - and imagining
that it would only be right to meet that cry, as well - is one hell of a leap.
Because whatever power Robert Rubin spied in the bond market, it really isn't
that bright.

Despite averaging just 0.40% real interest, for instance, through the 1970s,
buyers of 10-year US Treasuries took until Dec. 1980 to see their yield move
decisively above the pace of inflation. By then, of course, short-term rates
had shot up to 19%, first destroying the capital value of those 10-year bonds
as prices fell and yields rose towards that strongly positive post-inflation
return, but also destroying the easy returns to be made by borrowing short-term
money and lending it long.

Even below 3.0% today, ten-year US Treasuries still offer an easy profit -
quite literally money for nothing - in maturity
transformation. Those big institutions able to borrow Fed Funds at the
current near-zero rate can park those funds in government debt, picking up
2.75% returns from the annualized gap between overnight and 10-year interest.
This no-brainer gets brained, of course, when short rates rise above longer-term
yields. But what fear of that with Krugman's one-time colleague, fellow bearded
wonk Ben Bernanke, running the Fed?

Still, if there were a genuine problem with Uncle Sam's outstanding debt today
- a debt currently pegged at $13.1 trillion,
and equivalent to borrowing $2.82 each and every day since the Big Bang - then
the bond market would be first to know and show it. Right? Because as Krugman's
joking implies, the market-price of government debt must be correct in one
sense or another. He's clearly a big fan of the efficient
market hypothesis, no?

"There is nothing like deflation to bring on hyperinflation," as our friend,
Merryn Somerset Webb, recently reminded readers of the Financial Times and MoneyWeek.

"Governments desperate to prop up prices and economies, despite being broke,
print reams of money - money that eventually enters the market in a rush, flipping
deflation to inflation. If you can get a copy of Adam Ferguson's 1975 book When
Money Dies (soon to be republished), you will find an excellent account
of how this happened in the Weimar Republic. It might not happen again but,
at this point, it would surely be foolhardy to discount it entirely."

Zimbabwe's more recent collapse into hyperinflation might not strike the rich
West either, but it also bears notice. It began gently enough, with a mere
collapse of economic production and wages. Between 2001 and 2002, as "reflation" began,
the exchange rate of Zimbabwe Dollars to US$1 then held static around 55 (according
to the CIA
Factbook at least). Domestic Zimbabwean inflation, in contrast, was
galloping ahead at 134% per year, on course for doubling
shop prices every 24 hours by mid-2007, as the money-printing shown above
only accelerated the pace of catastrophe.

Put another way, "Most financial market indicators in the years leading up
to July 1914 implied a decline in the risks to investors," as Niall Ferguson
wrote in his 2006 tome, The War of the World. No, mounting political
concerns, saber-rattling and national armament didn't specifically forecast
the Archduke Francis Ferdinand's assassination on 28 June 1914 in Sarajevo,
and "bond prices did fall sharply once investors realized that a great-power
war was a real possibility. "But the striking thing is that this did not happen
until the last week of July 1914 - to be precise, in the week after the publication
of the Austrian ultimatum to Serbia, which demanded cooperation with an Austrian
enquiry."

One month after Austria lost its heir presumptive to an anarchist's bullet,
its bonds finally got round to dumping almost 10% of their value, says Ferguson's
data. The guns of August were already being loaded, in other words, by the
time the sovereign bond market took fright. Austrian debt would stand more
than 23% lower by Christmas, and the Hapsburg Empire wouldn't exist five years
from there.

Still, US Treasury buyers have nothing to fear today, of course. Just look
how low yields are.

Formerly City correspondent for The Daily Reckoning in London and head of
editorial at the UK's leading financial advisory for private investors, Adrian
Ash is the head of research at BullionVault,
where you can buy gold
today vaulted in Zurich on $3 spreads and 0.8% dealing fees.

About BullionVault

BullionVault is the
secure, low-cost gold and silver exchange for private investors. It enables
you to buy and sell professional-grade bullion at live prices online, storing
your physical property in market-accredited, non-bank vaults in London, New
York and Zurich.

By February 2011, less than six years after launch, more than 21,000 people
from 97 countries used BullionVault,
owning well over 21 tonnes of physical gold (US$940m) and 140 tonnes of physical
silver (US$129m) as their outright property. There is no minimum investment
and users can deal as little as one gram at a time. Each user's unique holding
is proven, each day, by the public reconciliation of client property with formal
bullion-market bar lists.

BullionVault is a
full member of professional trade body the London Bullion Market Association
(LBMA). Its innovative online platform was recognized in 2009 by the UK's prestigious
Queen's Awards for Enterprise. In June 2010, the gold industry's key market-development
body the World Gold Council (www.gold.org)
joined with the internet and technology fund Augmentum Capital, which is backed
by the London listed Rothschild Investment Trust (RIT Capital Partners), in
making an $18.8 million (£12.5m) investment in the business.

Please Note: This article is to inform your thinking, not lead it.
Only you can decide the best place for your money, and any decision you make
will put your money at risk. Information or data included here may have already
been overtaken by events - and must be verified elsewhere - should you choose
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